FNMA 5s outperformed substantially recently on news of the creation of two $5 billion Megas.
Lehman Brothers analysts said the coupon tightened by nearly 10 basis points LOAS, outperformed swaps by 14/32nds and the rest of the coupon stack by 7-8/32nds. Analysts note the market response is due to concern that a large portion of new WALA pools are parked in bank portfolios that do not roll MBS. In this event, the TBA deliverable could shift to late 2004 and 2003 vintages that are worth more than 2005 originations.
Following last summer's squeeze in that coupon, there has been a large amount of production, Lehman noted. Analysts from the firm calculate close to $55 billion of FNMA 5s with WALA less than 5. Minus the $25 billion in Mega creation for January and February leaves around $30 billion. Based on the last two months, this amount would suggest there should be no major shift in the deliverable, leading to a sharp correction in March. However, if more Megas are created in the following months, the current price response would be justified.
JPMorgan Securities analysts believe "claims of a permanent gapping shift in TBA WALA for the coupon appear unwarranted." In a report, analysts note there is about $60 billion in under 12 WALA remaining and $41 billion under 7. They expect for March settle, the TBA WALA would shift to seven months from four to five months in February. Analysts add the valuation difference is marginal. They estimate half of the 2004 float, or around $34 billion, appears to be locked up in bank portfolios, while most of the 2003 float ($120 billion) is available.
After analyzing the available float, analysts believe the most likely explanations for the recent strengthening in FNMA 5s include: a non-rolling investor bought $25 billion in FNMA 5s and market participants overreacted on a combination of fear and greed; and a non-rolling investor bought a net $25 billion in the coupon, but actually purchased more than $50 billion and sold the difference forward in order to obtain a more seasoned WALA. If either of these are the reason for the recent behavior in FNMA 5s, JPMorgan says the coupon could be "in for a major stumble in the next few weeks."
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